Considering an Adjustable-Rate Mortgage? Here’s What You Should Know (2024)

FAQs

Considering an Adjustable-Rate Mortgage? Here’s What You Should Know? ›

A mortgage is a loan that helps you buy a house. An adjustable-rate mortgage is just like any other mortgage, but with one important difference: the interest rate can go up or down. This means that your monthly payments could change over time, depending on what happens to interest rates.

When comparing adjustable rate mortgages and fixed rate mortgages, it's essential to consider how changes in interest rates could affect your monthly payment and long-term financial stability. Additionally, your credit score plays a crucial role in determining the interest rate you qualify for.

One of the biggest drawbacks of adjustable-rate mortgages is the uncertainty that comes with fluctuating interest rates. While the initial rate may be lower than a fixed-rate mortgage, it can also rise dramatically in the future, making monthly payments more expensive.

Here are some scenarios when an ARM might be a good choice. You're not buying a forever home. If you move in several years, an ARM could save you money. You'd benefit from the low introductory fixed rate, then sell the home before the adjustable period starts.

An ARM may make sense if the home buyer has a stable income and expects it to stay the same or increase. However, a fixed-rate mortgage may be a better choice if their income is less predictable or changing. With an ARM, the interest rate can change, which means monthly payments can also change.

Monthly payments might increase: The biggest disadvantage of an ARM is the likelihood of your rate going up. If rates have risen since you took out the loan, your payments will increase when the loan resets.

For many homebuyers, the risk may not be worth it

The reality is that for many homebuyers who want the lower payment of an adjustable rate loan, the added risk is often more than they can afford to take because they don't have a big income or vast savings.

Adjustable-rate (ARM) and fixed-rate (FRM) mortgages are most popular in the US. With an ARM contract, a borrower pays a varying interest rate, and bears interest rate risk. With an FRM contract, a borrower is charged a fixed interest rate, and interest rate risk is transferred to the lender.

Let's look at an example: The most common adjustable-rate mortgage is a 5/1 ARM. This means you will have an initial period of five years (the “5”), during which the interest rate doesn't change. After that time, you can expect your ARM to adjust once a year (the “1”).

Pros include low introductory rates and flexibility; cons include complexity and the potential for much bigger payments over time.

How often do adjustable-rate mortgages adjust? ›

For example, during the first five years in a 5/6m ARM your rate stays the same. After that, the rate may adjust every six months (the 6m in the 5/6m example) until the loan is paid off. This period between rate changes is called the adjustment period.

In this example the first “5” represents the maximum adjustment in interest rate for the first adjustment (i.e. during month 61), the “2” is the cap on future adjustments, and the last number, the other “5” is the maximum amount of change ever allowed.

The benefit of a fixed-rate mortgage is that your interest rate stays consistent. But your monthly mortgage bill can still change — in fact, it generally fluctuates at least a little bit every year. Rising home values and insurance premiums have caused unusually dramatic increases for some homeowners in recent years.

Mortgage Closing Waiting Period

The Rule prohibits the lender and consumer from closing or settling on the mortgage loan transaction until 7 business days after the delivery or mailing of the TILA disclosures, including the Good Faith Estimate and disclosure of the final APR.

However, if current 30-year mortgage rates are too high, a 5/1 ARM rate can make sense — especially if you're planning to relocate within five years. You may even want to stash the savings from a five-year ARM payment into a moving expense account.

7/1 ARMs can be a good option for those planning to sell their home or refinance within the first seven years, but may not be suitable for those planning to stay in their home for the long term or who are not prepared for potential rate increases.

An ARM has four components: (1) an index, (2) a margin, (3) an interest rate cap structure, and (4) an initial interest rate period. When the initial interest rate period has expired, the new interest rate is calculated by adding a margin to the index.

Keep your best interest in mind

These include credit scores (the higher your score, the better your rate), the length and size of the loan, and even the rate of inflation. A good mortgage loan officer can walk you through these factors and help you determine whether they will alter your rate.